# Capital Budgeting Decisions: Multiple Choice

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**Capital Budgeting Decisions**

**Multiple Choice**

- Some investment projects require that a company increase its working capital. Under the net present value method, the investment and eventual recovery of working capital should be treated as:
- A) an initial cash outflow.
- B) a future cash inflow.
- C) both an initial cash outflow and a future cash inflow.
- D) irrelevant to the net present value analysis.

- The net present value (NPV) method of investment project analysis assumes that the project’s cash flows are reinvested at the:
- A) internal rate of return.
- B) discount rate used in the NPV calculation.
- C) firm’s simple rate of return.
- D) firm’s average ROI.

- If taxes are ignored, all of the following items are included in a discounted cash flow analysis except:
- A) future operating cash savings.
- B) depreciation expense.
- C) future salvage value.
- D) investment in working capital.

- In capital budgeting computations, discounted cash flow methods:
- A) automatically provide for recovery of initial investment.
- B) can’t be used unless cash flows are uniform from year to year.
- C) assume that all cash flows occur at the beginning of a period.
- D) responses a, b, and c are all correct.

- The investment required for the project profitability index should:
- A) be reduced by the amount of any salvage recovered from the sale of old equipment.
- B) be reduced by the amount of any salvage recovered from the sale of the new equipment at the end of its useful life.
- C) be reduced by the amount of any salvage recovered from the sale of both the old and new equipment.
- D) none of the above is correct.

- A company wants to have $40,000 at the end of a five-year period through investment of a single sum now. How much needs to be invested in order to have the desired sum in five years, if the money can be invested at 10%:
- A) $10,551
- B) $8,000
- C) $24,840
- D) $12,882

- The following data on a proposed investment project have been provided:

The net present value of the project would be:

- A) $3,730
- B) $0
- C) $32,450
- D) $88,370

- Stratford Company purchased a machine with an estimated useful life of seven years. The machine will generate cash inflows of $9,000 each year over the next seven years. If the machine has no salvage value at the end of seven years, and assuming the company’s discount rate is 10%, what is the purchase price of the machine if the net present value of the investment is $17,000?
- A) $43,812
- B) $26,812
- C) $17,000
- D) $22,195

- Anthony operates a part time auto repair service. He estimates that a new diagnostic computer system will result in increased cash inflows of $1,500 in Year 1, $2,100 in Year 2, and $3,200 in Year 3. If Anthony’s required rate of return is 10%, then the most he would be willing to pay for the new computer system would be:
- A) $4,599
- B) $5,501
- C) $5,638
- D) $5,107

- Fossa Road Paving Company is considering an investment in a curb-forming machine. The machine will cost $240,000, will last 10 years, and will have a $40,000 salvage value at the end of 10 years. The machine is expected to generate net cash inflows of $60,000 per year in each of the 10 years. Fossa’s discount rate is 18%. What is the net present value of this machine?
- A) $5,840
- B) $37,280
- C) $(48,780)
- D) $69,640

- Apnea Video Rental Store is considering the purchase of an almost new minivan to use as a vehicle to deliver and pick up video tapes for customers. The minivan will cost $18,000 and is expected to last 8 years but only if the engine is overhauled at a cost of $3,000 at the end of year 3. The minivan is expected to have a $1,000 salvage value at the end of 8 years. This delivery service is expected to generate net cash inflows of $6,000 per year in each of the 8 years. Apnea’s discount rate is 14%. What is the net present value of this investment opportunity?
- A) $(2,826)
- B) $(3,801)
- C) $7,185
- D) $8,160

- In an effort to reduce costs, Pontic Manufacturing Corporation is considering an investment in equipment that will reduce defects. This equipment will cost $420,000, will have an estimated useful life of 10 years, and will have an estimated salvage value of $50,000 at the end of 10 years. Pontic’s discount rate is 22%. What amount of cost savings will this equipment have to generate per year in each of the 10 years in order for it to be an acceptable project?
- A) $50,690 or more
- B) $41,315 or more
- C) $105,315 or more
- D) $94,316 or more

- Naomi Corporation has a capital budgeting project that has a negative net present value of $36,000. The life of this project is 6 years. Naomi’s discount rate is 20%. By how much would the annual cash inflows from this project have to increase in order to have a positive net present value?
- A) $1,200 or more
- B) $2,412 or more
- C) $6,000 or more
- D) $10,824 or more

- A project requires an initial investment of $70,000 and has a project profitability index of 0.932. The present value of the future cash inflows from this investment is:
- A) $70,000
- B) $36,231
- C) $135,240
- D) Cannot be determined from the data provided.

- Bowen Company is considering several investment proposals, as shown below:

If the project profitability index is used, the ranking of the projects would be:

- A) A above
- B) B above
- C) C above
- D) D above

- Information on four investment proposals is given below:

Rank the proposals in terms of preference according to the project profitability index:

- A) 1, 4, 3, 2
- B) 4, 1, 3, 2
- C) 3, 4, 1, 2
- D) 2, 1, 4, 3

- Information on four investment proposals is given below:

Rank the proposals in terms of preference using the project profitability index:

- A) 3, 2, 1, 4
- B) 2, 3, 1, 4
- C) 2, 1, 3, 4
- D) 4, 1, 2, 3

- The Gomez Company is considering two projects, T and V. The following information has been gathered on these projects:

Based on this information, which of the following statements is (are) true?

- Project T has the highest ranking according to the project profitability index criterion.
- Project V has the highest ranking according to the net present value criterion.

- A) Only I
- B) Only II
- C) Both I and II
- D) Neither I nor II

- Major Corporation is considering the purchase of a new machine for $5,000. The machine has an estimated useful life of 5 years and no salvage value. The machine will increase Major’s cash flows by $2,000 annually for 5 years. Major uses straight-line depreciation. The company’s required rate of return is 10%. What is the payback period for the machine?
- A) 5.00 years
- B) 2.50 years
- C) 7.58 years
- D) 8.34 years

- Harrison Company is studying a project that would have an eight-year life and would require a $300,000 investment in equipment which has no salvage value. The project would provide net operating income each year as follows for the life of the project:

The company’s required rate of return is 10%. What is the payback period for this project?

- A) 3 years
- B) 2 years
- C) 2.5 years
- D) 2.67 years

- An investment project requires an initial investment of $100,000. The project is expected to generate net cash inflows of $28,000 per year for the next five years. Assuming a 12% discount rate, the project’s payback period is:
- A) 0.28 years
- B) 3.36 years
- C) 3.57 years
- D) 1.40 years

Source: CMA, adapted

- Mercer Corporation is considering replacing a technologically obsolete machine with a new state-of-the-art numerically controlled machine. The new machine would cost $250,000 and would have a ten-year useful life. Unfortunately, the new machine would have no salvage value. The new machine would cost $12,000 per year to operate and maintain, but would save $55,000 per year in labor and other costs. The old machine can be sold now for scrap for $10,000. The simple rate of return on the new machine is closest to:
- A) 17.9%
- B) 7.5%
- C) 22.0%
- D) 7.2%

- Pearson Co. is considering the purchase of a $200,000 machine that is expected to reduce operating cash expenses by $65,000 per year. This machine, which has no salvage value, has an estimated useful life of 5 years and will be depreciated on a straight-line basis. For this machine, the simple rate of return would be:
- A) 10%
- B) 12.5%
- C) 20%
- D) 32.5%

- Assume you can invest money at a 14% rate of return. How much money must be invested now in order to be able to withdraw $5,000 from this investment at the end of each year for 8 years, the first withdrawal occurring one year from now?
- A) $24,840
- B) $23,195
- C) $21,440
- D) $1,755

- How much would you have to invest today in the bank at an interest rate of 5% to have an annuity of $1,400 per year for 5 years, with nothing left in the bank at the end of the 5 years? Select the amount below that is closest to your answer.
- A) $6,667
- B) $6,061
- C) $7,000
- D) $1,098

- You have deposited $15,584 in a special account that has a guaranteed interest rate. If you withdraw $3,700 at the end of each year for 5 years, you will completely exhaust the balance in the account. The guaranteed interest rate is closest to:
- A) 6%
- B) 19%
- C) 24%
- D) 4%

- You have deposited $16,700 in a special account that has a guaranteed interest rate of 11% per year. If you are willing to completely exhaust the account, what is the maximum amount that you could withdraw at the end of each of the next 6 years? Select the amount below that is closest to your answer.
- A) $3,465
- B) $3,089
- C) $2,783
- D) $3,947

- Latting Corporation has entered into a 7 year lease for a building it will use as a warehouse. The annual payment under the lease will be $4,781. The first payment will be at the end of the current year and all subsequent payments will be made at year-ends. What is the present value of the lease payments if the discount rate is 6%?
- A) $31,573
- B) $22,257
- C) $33,467
- D) $26,688

- Schaad Corporation has entered into a 8 year lease for a piece of equipment. The annual payment under the lease will be $2,500, with payments being made at the beginning of each year. If the discount rate is 14%, the present value of the lease payments is closest to:
- A) $20,000
- B) $7,011
- C) $17,544
- D) $13,220

- Tangen Corporation is considering the purchase of a machine that would cost $380,000 and would last for 6 years. At the end of 6 years, the machine would have a salvage value of $80,000. By reducing labor and other operating costs, the machine would provide annual cost savings of $104,000. The company requires a minimum pretax return of 14% on all investment projects. The net present value of the proposed project is closest to:
- A) $104,456
- B) $24,456
- C) $133,753
- D) $60,936

- The management of Urbine Corporation is considering the purchase of a machine that would cost $350,000, would last for 6 years, and would have no salvage value. The machine would reduce labor and other costs by $79,000 per year. The company requires a minimum pretax return of 14% on all investment projects. The net present value of the proposed project is closest to:
- A) -$42,769
- B) $124,000
- C) -$93,877
- D) $56,493

- Riveros, Inc., is considering the purchase of a machine that would cost $120,000 and would last for 8 years. At the end of 8 years, the machine would have a salvage value of $29,000. The machine would reduce labor and other costs by $25,000 per year. Additional working capital of $9,000 would be needed immediately. All of this working capital would be recovered at the end of the life of the machine. The company requires a minimum pretax return of 18% on all investment projects. The net present value of the proposed project is closest to:
- A) -$18,050
- B) -$63,683
- C) -$10,336
- D) -$16,942

- The management of Edelmann Corporation is considering the following three investment projects:

Rank the projects according to the profitability index, from most profitable to least profitable.

- A) T,S,R
- B) R,T,S
- C) S,T,R
- D) T,R,S

- Villena Corporation is considering a project that would require an investment of $48,000. No other cash outflows would be involved. The present value of the cash inflows would be $52,800. The profitability index of the project is closest to:
- A) 0.90
- B) 0.10
- C) 1.10
- D) 0.09

- Crowley Corporation is considering three investment projects-F, G, and H. Project F would require an investment of $21,000, Project G of $49,000, and Project H of $82,000. No other cash outflows would be involved. The present value of the cash inflows would be $21,210 for Project F, $57,820 for Project G, and $95,120 for Project H. Rank the projects according to the profitability index, from most profitable to least profitable.
- A) F,H,G
- B) G,H,F
- C) H,F,G
- D) H,G,F

- The management of Cantell Corporation is considering a project that would require an initial investment of $47,000. No other cash outflows would be required. The present value of the cash inflows would be $55,930. The profitability index of the project is closest to:
- A) 1.19
- B) 0.81
- C) 0.19
- D) 0.16

- Kautzer Corporation is considering a project that would require an investment of $418,000 and would last for 9 years. The incremental annual revenues and expenses generated by the project during those 9 years would be as follows:

The scrap value of the project’s assets at the end of the project would be $13,000. The payback period of the project is closest to:

- A) 5.9 years
- B) 6.1 years
- C) 17.4 years
- D) 16.9 years

- The management of Helberg Corporation is considering a project that would require an investment of $203,000 and would last for 6 years. The annual net operating income from the project would be $103,000, which includes depreciation of $30,000. The scrap value of the project’s assets at the end of the project would be $23,000. The payback period of the project is closest to:
- A) 1.5 years
- B) 2.0 years
- C) 1.4 years
- D) 1.7 years

- Wombles Corporation is contemplating purchasing equipment that would increase sales revenues by $478,000 per year and cash operating expenses by $249,000 per year. The equipment would cost $738,000 and have a 9 year life with no salvage value. The annual depreciation would be $82,000. The simple rate of return on the investment is closest to:
- A) 19.9%
- B) 30.8%
- C) 31.0%
- D) 11.1%

- The management of Duker Corporation is investigating purchasing equipment that would increase sales revenues by $130,000 per year and cash operating expenses by $39,000 per year. The equipment would cost $328,000 and have an 8 year life with no salvage value. The simple rate of return on the investment is closest to:
- A) 12.5%
- B) 27.7%
- C) 38.5%
- D) 15.2%

- An expansion at Fidell, Inc., would increase sales revenues by $75,000 per year and cash operating expenses by $38,000 per year. The initial investment would be for equipment that would cost $135,000 and have a 5 year life with no salvage value. The annual depreciation on the equipment would be $27,000. The simple rate of return on the investment is closest to:
- A) 20.0%
- B) 7.4%
- C) 27.4%
- D) 13.3%

- Messersmith Corporation is investigating automating a process by purchasing a machine for $688,000 that would have an 8 year useful life and no salvage value. By automating the process, the company would save $160,000 per year in cash operating costs. The new machine would replace some old equipment that would be sold for scrap now, yielding $19,000. The annual depreciation on the new machine would be $86,000. The simple rate of return on the investment is closest to:
- A) 23.3%
- B) 11.1%
- C) 10.8%
- D) 12.5%

- The management of Stanforth Corporation is investigating automating a process. Old equipment, with a current salvage value of $24,000, would be replaced by a new machine. The new machine would be purchased for $516,000 and would have a 6 year useful life and no salvage value. By automating the process, the company would save $173,000 per year in cash operating costs. The simple rate of return on the investment is closest to:
- A) 17.7%
- B) 16.9%
- C) 33.5%
- D) 16.7%

Use the following to answer 54-56

Overland Company has gathered the following data on a proposed investment project:

The company uses straight-line depreciation on all equipment.

- The payback period for the investment is:
- A) 0.27 years
- B) 3.75 years
- C) 10.00 years
- D) 2.13 years

- The simple rate of return on the investment is:
- A) 26.67%
- B) 16.67%
- C) 36.67%
- D) 10.00%

- The net present value of this investment is:
- A) $40,000
- B) $3,625
- C) $57,831
- D) $95,800

Use the following to answer 57-59

Perky Food Corporation produces and sells coffee jelly. Perky currently produces the jelly using a manual operation but is considering the purchase of machinery to automate its operations. Information related to the two operations is as follows:

Perky’s discount rate is 12%. Perky uses the straight-line method of depreciation.

- What is the net present value of automating operations using the incremental cost approach?
- A) $11,940
- B) $56,940
- C) $(104,106)
- D) $112,684

- What is the simple rate of return for automating operations?
- A) 3.8%
- B) 12.1%
- C) 14.5%
- D) 22.9%

- What will be the effect on the net present value of the decision to automate operations if 60,000 jars instead of 50,000 jars are expected to be sold each year? (Assume no change in cost structure or selling price.)
- A) no effect
- B) $52,030 decrease
- C) $63,179 increase
- D) $115,208 increase

Use the following to answer 60-62

Tam Company is negotiating for the purchase of equipment that would cost $100,000, with the expectation that $20,000 per year could be saved in cash operating costs. The equipment’s estimated useful life is 10 years, with no salvage value, and would be depreciated by the straight-line method. Tam’s required rate of return is 12%.

- The net present value of this investment is:
- A) $5,760
- B) $6,440
- C) $12,200
- D) $13,000

Source: CPA, adapted

- The payback period of this investment is:
- A) 4 years
- B) 1 year
- C) 10 years
- D) 5 years

- The simple rate of return of this investment is:
- A) 8%
- B) 20%
- C) 12%
- D) 10%

Use the following to answer 63-64

Evans Company is considering rebuilding and selling used alternators for automobiles. The company estimates that the net cash flows (sales less cash operating expenses) arising from the rebuilding and sale of the used alternators would be as follows:

In addition, Evans Company would need to purchase equipment costing $275,000. The equipment would have a 12 year life and a $25,000 salvage value. The company’s required rate of return is 10%.

- The payback period on this investment is:
- A) 3.00 years
- B) 2.75 years
- C) 1.50 years
- D) 4.00 years

- The net present value of the project is closest to:
- A) $364,090
- B) $372,065
- C) $339,090
- D) $389,090

Use the following to answer 65-66

Baldock Inc. is considering the acquisition of a new machine that costs $420,000 and has a useful life of 5 years with no salvage value. The incremental net operating income and incremental net cash flows that would be produced by the machine are:

- If the discount rate is 12%, the net present value of the investment is closest to:
- A) $330,000
- B) $539,365
- C) $119,365
- D) $420,000

- The payback period of this investment is closest to:
- A) 5.0 years
- B) 3.2 years
- C) 1.9 years
- D) 2.8 years

Use the following to answer 67-68

Delley Inc. is considering the acquisition of equipment that costs $340,000 and has a useful life of 6 years with no salvage value. The incremental net cash flows that would be generated by the equipment are:

- If the discount rate is 17%, the net present value of the investment is closest to:
- A) $45,811
- B) $385,811
- C) $301,000
- D) $117,341

- The payback period of this investment, rounded off to the nearest tenth of a year, is closest to:
- A) 3.9 years
- B) 3.6 years
- C) 3.1 years
- D) 5.0 years

Use the following to answer 69-70

Westland College has a telephone system that is in poor condition. The system either can be overhauled or replaced with a new system. The following data have been gathered concerning these two alternatives:

Westland College uses a 10% discount rate and the total cost approach to capital budgeting analysis. The working capital required under the new system would be released for use elsewhere at the conclusion of the project. Both alternatives are expected to have a useful life of eight years.

69. The net present value of overhauling the present system is:

- A) $(321,084)
- B) $(532,516)
- C) $(560,536)
- D) $(592,516)

- The net present value of the new system alternative is:
- A) $(483,095)
- B) $(583,095)
- C) $(596,395)
- D) $(536,395)

Use the following to answer 71-72

Lambert Manufacturing has $100,000 to invest in either Project A or Project B. The following data are available on these projects:

Both projects will have a useful life of 6 years. At the end of 6 years, the working capital investment will be released for use elsewhere. Lambert’s required rate of return is 14%. The company uses the total cost approach to evaluating alternatives.

- The net present value of Project A is:
- A) $51,000
- B) $60,120
- C) $55,560
- D) $94,450

- The net present value of Project B is:
- A) $90,355
- B) $76,115
- C) $36,115
- D) $54,355

Use the following to answer 73-75

Carlson Manufacturing has some equipment that needs to be rebuilt or replaced. The following information has been gathered relative to this decision:

Carlson uses the total cost approach and a discount rate of 12%. Regardless of which option is chosen, rebuild or replace, at the end of five years Carlson Manufacturing plans to close its domestic manufacturing operations and to move these operations to foreign countries.

- If the new equipment is purchased, the present value of all cash flows that occur now is:
- A) $(48,000)
- B) $(39,000)
- C) $(41,000)
- D) $(37,000)

- If the new equipment is purchased, the present value of the annual cash operating costs associated with this alternative is:
- A) $(28,840)
- B) $(19,160)
- C) $(14,420)
- D) $(36,050)

- If the equipment is rebuilt, the present value of all cash flows that occur now is:
- A) $(55,000)
- B) $(25,000)
- C) $(16,000)
- D) $(23,000)

Use the following to answer 76-79

Cedar Hill Hospital needs to expand its facilities and desires to obtain a new building on a piece of property adjacent to its present location. Two options are available to Cedar Hill, as follows:

Option 1: Buy the property, erect the building, and install the fixtures at a total cost of $600,000. This cost would be paid off in five installments: an immediate payment of $200,000, and a payment of $100,000 at the end of each of the next four years. The annual cash operating costs associated with the new facilities are estimated to be $12,000 per year. The new facilities would be occupied for thirteen years, and would have a total resale value of $300,000 at the end of the 13-year period.

Option 2: A leasing company would buy the property and construct the new facilities for Cedar Hill which would then be leased back to Cedar Hill at an annual lease cost of $70,000. The lease period would run for 13 years, with each payment being due at the BEGINNING of the year. Additionally, the company would require an immediate $10,000 security deposit, which would be returned to Cedar Hill at the end of the 13-year period. Finally, Cedar Hill would have to pay the annual maintenance cost of the facilities, which is estimated to be $4,000 per year. There would be no resale value at the end of the 13-year period under this option.

The hospital uses a discount rate of 14% and the total-cost approach to net present value analysis in evaluating its investment decisions.

- Under option 1, the present value of all cash outflows associated with buying the property, erecting the building, and installing the fixtures is closest to:
- A) $(200,000)
- B) $(491,400)
- C) $(600,000)
- D) $(387,200)

- Under option 1, the net present value of all cash flows is closest to:
- A) $(456,000)
- B) $(600,000)
- C) $(300,000)
- D) $(507,000)

- Under option 2, the present value of all the annual lease payments of $70,000 is closest to:
- A) $(466,200)
- B) $(408,900)
- C) $(483,700)
- D) $(910,000)

- Under option 2, the present value of all cash flows associated with maintenance costs is closest to:
- A) $(23,400)
- B) $(52,000)
- C) $(70,100)
- D) $(4,000)

Use the following to answer 80-81

Clairmont Corporation is considering the purchase of a machine that would cost $150,000 and would last for 5 years. At the end of 5 years, the machine would have a salvage value of $18,000. By reducing labor and other operating costs, the machine would provide annual cost savings of $37,000. The company requires a minimum pretax return of 12% on all investment projects.

- The present value of the annual cost savings of $37,000 is closest to:
- A) $133,385
- B) $235,070
- C) $185,000
- D) $20,979

- The net present value of the proposed project is closest to:
- A) -$6,409
- B) -$11,295
- C) $1,385
- D) -$16,615

Reference: 12_12

Use the following to answer 82-83

The management of Mashiah Corporation is considering the purchase of a machine that would cost $290,000, would last for 6 years, and would have no salvage value. The machine would reduce labor and other costs by $102,000 per year. The company requires a minimum pretax return of 13% on all investment projects.

- The present value of the annual cost savings of $102,000 is closest to:
- A) $849,012
- B) $612,000
- C) $195,872
- D) $407,796

- The net present value of the proposed project is closest to:
- A) $154,663
- B) $322,000
- C) $117,796
- D) $245,246

Use the following to answer 84-85

Lebert, Inc., is considering the purchase of a machine that would cost $380,000 and would last for 7 years. At the end of 7 years, the machine would have a salvage value of $49,000. The machine would reduce labor and other costs by $96,000 per year. Additional working capital of $6,000 would be needed immediately. All of this working capital would be recovered at the end of the life of the machine. The company requires a minimum pretax return of 18% on all investment projects.

- The combined present value of the working capital needed at the beginning of the project and the working capital released at the end of the project is closest to:
- A) $16,872
- B) $0
- C) -$4,116
- D) -$13,111

- The net present value of the proposed project is closest to:
- A) $1,338
- B) -$8,849
- C) -$14,048
- D) -$2,778

Use the following to answer 86-87

Dube Corporation is considering the following three investment projects:

- The profitability index of investment project E is closest to:
- A) 0.13
- B) 1.13
- C) 0.87
- D) 0.12

- Rank the projects according to the profitability index, from most profitable to least profitable.
- A) F,E,D
- B) D,F,E
- C) F,D,E
- D) E,F,D

Use the following to answer 88-89

The management of Keno Corporation is considering three investment projects-B, C, and D. Project B would require an investment of $15,000, Project C of $50,000, and Project D of $89,000. The present value of the cash inflows would be $16,350 for Project B, $56,500 for Project C, and $96,120 for Project D.

- The profitability index of investment project C is closest to:
- A) 0.13
- B) 0.87
- C) 0.12
- D) 1.13

- Rank the projects according to the profitability index, from most profitable to least profitable.
- A) B,D,C
- B) C,B,D
- C) D,C,B
- D) D,B,C